Kass: A Correction Is in the Cards

This blog post originally appeared on RealMoney Silver on July 16 at 7:29 a.m. EDT.

A trifecta of salutary news events at BP (BP), Goldman Sachs (GS) and at Apple (AAPL) served to reverse a definitive morning market slide that appeared to be induced by a series of economic releases (Philly Fed and Empire State Survey that suggested U.S. industrial output has stalled.

It still remains my view that the S&P 500 has made its low for the year, but, from my perch, the developing downbeat economic conditions will trump the nonrecurring events at BP, Goldman Sachs and Apple, and, in the days ahead, stocks will erase some of the recent breathtaking gains.

Prior to the recent soft patch, most economists and strategists expected a self-sustaining economic recovery that might average at least 3% GDP growth. Now, many of those same economists and strategists are begrudgingly reducing their growth forecasts and taking the slippery slope by rationalizing their bullish S&P targets, and they are making a valuation case and/or identifying negative extremes in sentiment (whether it is in a growing bears/bull ratio, the absence of flows into domestic equity funds or in investor fervor/popularity associated with the fixed-income market) to do so.

I believe that, in the fullness of time, the bulls might be right, but the magnitude of the economic weakness is now debatable and is most certainly unresolved. (Goldman Sachs' Jan Hatzius is calling the U.S. industrial economy in "virtual stall.")

Coincident with the recent boisterous rally, many are growing more optimistic, but, unlike the momentum crowd that relishes in buying strength and selling weakness, I prefer to do the opposite. Why would I prefer to buy XYZ stock at $12 a share when it was $10 a share two weeks ago? And why would I sell ABC stock at $10 a share when it was $12 a share two weeks ago? I suppose the high-frequency-trading nerds have the answer!

Stated simply, buying stocks into the recent market strength runs the principal risk that economic activity will continue to falter and that stocks will cheapen, and that is a bet I am reluctant to make at current prices. This is especially true as we move ever closer to a large tax spike in early 2011.